New claims for unemployment benefits dropped more than expected last week to their lowest level in more than two years, suggesting the labor market recovery was gaining strength.

Initial claims for state unemployment benefits fell 34,000 to a seasonally adjusted 388,000, the lowest reading since early July 2008, the Labor Department said on Thursday. That was well below economists' expectations for 415,000.

The prior week's claims figure was revised modestly up to 422,000 from the previously reported 420,000. A Labor Department official said there was nothing unusual in the state-level data and described the report as clean.

This adds to the idea that the jobs picture is improving ... this is another feather in the cap of the idea of recovery, said Adam Sarhan, chief executive of Sarhan Capital in New York.

U.S. Treasury debt prices, already soft before the data, lost more ground, while the dollar pared losses against the yen. S&P stock index futures trimmed losses.

The four-week average of new jobless claims, considered a better measure of underlying labor market trends, fell 12,500 to 414,000, the lowest level since the week ending July 26, 2008.

The steady decline in claims in recent weeks likely indicates the pace of job creation picked up this month, after the Labor Department's non-farm payrolls report showed employers added a paltry 39,000 jobs in November.

The December employment data is due on January 7, and a preliminary Reuters survey shows economists expect non-farm payrolls increased 126,000 this month, but still not enough to significantly reduce the unemployment rate, which is expected to have edged down to 9.7 percent from 9.8 percent in November.

The claims data also showed the number of people still receiving benefits under regular state programs after an initial week of aid rose 57,000 to 4.13 million in the week ended December 18, above market expectations for 4.10 million. The prior week's figure was revised slightly up to 4.07 million.

The so-called continuing claims data covered the survey week for the December employment report's household survey from which the unemployment rate is derived.

The jobless rate is likely to remain elevated as the improving labor market and general economic conditions lure discouraged job seekers back into the labor force.

The number of people on emergency unemployment benefits fell 77,741 to 3.71 million in the week ended December 11, the latest week for which data is available.

A total of 8.87 million people were claiming unemployment benefits during that period under all programs.

Unemployment